The Dangers of Cohabitation

Much has been made of the benefits to smaller beer, wine and spirits companies of the recently enacted tax reforms. And rightfully so, as the reduction in federal excise tax on these products should – standing alone – provide a meaningful benefit to affected companies. But of course there are some potential pitfalls as well.

When I was an adolescent, I can recall family members (and more than one Sunday School teacher) refer to cohabitation as “living in sin.” Always a curious phrase, really. And candidly, that description sounded pretty attractive despite the fact that I was then at an age where living in sin with a young lady wasn’t really on the table as an option. But now that the Tax Cuts and Jobs Act (and yes, I know that isn’t its official name) has been put into law, I can see how cohabitation – at least with respect to booze production – can be both attractive and damaging.

Here’s the deal. The TCJA provides for a stairstep reduction in FET to spirits producers removing from bond up to various amounts of spirit. And you might think that only the production of your company would be relevant for purposes of determining the number of proof gallons you remove from bond. That would be a reasonable assumption. And it would also – at least potentially – be incorrect.

A little-discussed provision in the TCJA provides that – in some cases – you may need to combine the production of two or more companies for purposes of determining where you sit in the FET stair-step. Specifically, Section 401(a) of the TCJA inserts the following provision into Internal Revenue Code Section 5001:

(D) SINGLE TAXPAYER.—Pursuant to rules issued by the Secretary, two or more entities (whether or not under common control) that produce distilled spirits marketed under a similar brand, license, franchise, or other arrangement shall be treated as a single taxpayer for purposes of the application of this subsection.

What does this mean? It means that if you’ve got more than one producer of a specific brand of spirit, you need to aggregate the production of all of those producers for purposes of determining the total production and where you sit in the FET stair-step.

Suppose, for example, you develop an interesting whiskey (let’s call it “BeetleButt Bourbon“) and begin producing it in your home state of Maine. Things are going swimmingly and after a few years of production you’re selling roughly 75,000 proof gallons per year BeetleButt – with distribution throughout the eastern United States. Now suppose that you attend the upcoming American Distilling Institute conference in Portland and you meet up with an interesting fellow distiller who operates a distillery in Southern California. Your new friend just happens to have extra production capacity at her distillery and is looking for a whiskey to add to her product lineup. Together – while attending a cool dinner event on the Monday night of the conference (more on that later) the two of you hatch a plan that will allow her to produce and sell BeetleButt , limiting her distribution to the western United States. So far so good, right?

Under this new provision, you and your new best friend will need to add together the amount of BeetleButt that you collectively are removing from bond for purposes of determining your FET liability. And as soon as the two of you collectively remove more than 100,000 proof gallons from bond in any particular year, you’re now outside the $2.70/proof gallon FET rate and have the privilege of paying $13.34 for every proof gallon above the threshold. Ouch.

Even better, because we don’t yet have the IRS regulations that will be developed to interpret this provision of the TCJA, we don’t really know how much pain and aggravation this aggregation will cause. Your hypothetical friend added BeetleButt to her product lineup – meaning she produces other products as well. It is possible (but we won’t really know for sure until the regulations are written and effective) that she will fall outside the $2.70 FET rate for all spirits she removes from bond above the 100,000 proof gallon threshold (assuming aggregation with your production), even if BeetleButt is only a very small portion of her total product offering and even if collectively her sales of your whiskey – plus all the other spirit she sells but without aggregation of your product – is below the 100,000 proof gallon threshold.

Talk about a trap for the unwary – this tax stuff is complicated.

With that out of the way – let’s get back to the issue of the cool dinner on the Monday night of the conference. This post, I’m pleased to say, is the 100th installment of HoochLaw. And some weeks back – when I saw that we were approaching this milestone – I put out on Twitter (@BrianBDeFoe) a poll asking people how we should celebrate. The winner by a very slim margin was that we should have a party. So that’s what we’re going to do. In the evening of Monday, March 26 – after the initial spirits tasting – we will host a dinner party for 20 or so friends in the distilling community. You may be invited.

If you’re interested in getting an invite to what will undoubtedly be the hottest ticket in PDX that night – or at least the one most likely to involve a tweed-wearing bowtie clad HoochLawyer – shoot me a message (through email or Twitter) telling me why you want to attend. Requests for tickets will be judged on the basis of creativity and my overall estimation of your expected contribution to the quality of dinner conversation. I’ll pick a few entries and add them to the invite list.

This is going to be a great event – I hope to see you there.

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Published by Brian B. DeFoe

A business lawyer with an emphasis on assisting clients in consumer-facing industries, especially hospitality and retail. I have a keen appreciation for spirits, especially single-malt scotch whiskies (the peatier the better, please) and robust bourbons.
I live on Bainbridge Island, Washington with my wife, three sons and an ever changing menagerie. My practice is based out of Seattle.
View all posts by Brian B. DeFoe